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Archive for August 2013

Bitcoins: a version of tulipomania

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ImageBitcoin value will crash, even if it goes through bubble phase of tulipomania scenario first. Bitcoin (or BTC) is worth something just because of market participants believe it is worth something. Why people keep buying BTC? Fun of participating in something novel plays a role for some. Greed should be present as the price increase looks like no-brainer to others. Certainly some of BTC value derives not from what it is, but rather what it is not.  What it is NOT: is not a fiat currency that may devalued by “printing press”, authorities can’t [yet] track down or block every single transaction, storage of the value is not dependent on solvency of any particular institution etc.

Video: You Really Should be Buying Bitcoin (a good explanatory video on BTC)

Without any central institution to destroy the value, no oppressive body to track and/or tax it and, generally, ease of transactions, for many BTC certainly is an attractive alternative to money. At this stage, BTC can perform the essential functions of money — medium of exchange, store of value, measurement of value, no question about it.

There is one trait what sets BTC apart from any other money equivalent: the amount of BTC in circulation capped at 21 million. Even reaching this limit will take some time, as the cost of mining BTC is already higher than their current market value.

We can certainly imagine that in near future an infrastructure is in place to make transactions easy. Easier than cash. Like to make payment with NFC phone and Mastercard Paypass installed, for example. In fact, the technology is in place already. It is just the matter of adaptation by users.

So with all the wonderful specs why BTC is just another bubble? Something free from malaises of fiat money, something quantitatively more limited than gold or diamonds, as anonymous [yet] as gold or diamonds, no storage cost, ease of transaction and at price what is less than production cost.

The reasons BTC as a currency are doomed:

  1. Non-debaseable money – true, but it is not unique and for BTC serves no purpose
    The number of BTC is limited by its algorithm at 21 million. However, so can be any other crypto currency (like litecoin), it is a question of mathematic algorithm. To a certain extend non-debasable are gold, silver, land etc. as well – all of which have gone through boom and bust. What is worse, 21 million BTC in circulation is a setback for development as money. If BTC was to replace all the fiat money in circulation, any single BTC would be worth millions (imagine global GDP of about US$71 trillion to be serviced by 21 million of BTC in circulation) and price of cup of coffee would be expressed as 0.000001 or less BTC – not very practical.
  2. Easy replicable by other crypto currency algorithms
    It is a crypto currency. BTC is based on one specific mathematical algorithm. Similar algorithms are easy to create. Litecoin is one example. Other crypto currencies may appear in endless variations. Such other crypto currencies are likely to be suitable for transaction using the same infrastructure as BTC. For all practical purposes, if somebody creates a crypto currency with global ambition to replace fiat money, for all practical purposes it is better to create something with 71 trillion rather and 21 million units in circulation.
  3. Anonymity will disappear
    Several governments have moved to bring BTC under regulation. US has recognized it as “virtual currency”, Germany as “financial instrument” – whatever the name, in any case BTC is an asset, which is subject government surveillance for anti-money laundering, licensing and tax purposes. All BTC transactions leave a trail on internet. BTC anonymity is not there to stay. In a sense, BTC is a victim of its own popularity as it attracts government scrutiny.
  4. Momentum will fade
    The momentum of novelty will fade. Probably most people on retail level get involved in BTC for fun. This factor will wear off eventually. Speculative interest will disappear after first crush. If all that backs BTC is confidence, then confidence may easily be highly volatile factor. Particularly when people recognize that behind BTC there is nothing else but the confidence.
  5. Technological risks
    The technology of mining, transacting and storing of BTC is new and critical flaws may appear.

All said, the key lesson from BTC is that interest (demand, need) for an alternative currency is strong and I expect that some properly backed, non-national currency will be invented.

Is it a sensible thing to invest money in BTC? I do not think so. The thing of BTC funds with 1000% annual returns may be the thing of the past. Have people made money of it. Absolutely. Early miners, for example. Today mining is not profitable. Will value of BTC increase? No idea, but tulipomania scenario is quite probable. I guess, there are people who know how to trade through bubbles. Is there any practical value of BTC? Apart from entertainment and promoting a novel idea, BTC actually can help to move funds cross-border below government radar scrutiny (something one cannot do with any major national currency). At least by now, but knowing government dislike for it as showed by Liberty Reserve case and having US$11b budget and 35k persons to go after it, it is unlikely the loophole will persist for long.

Written by A.S.

August 30, 2013 at 7:47 pm